Do Consoles Have a Future?

Tim Merel of investment bank Digi-Capital on how to leverage console brands in a mobile and online space

While recent headlines such as "Game sales crash" and "Games retail collapses" don't paint a rosy picture, we believe the report of the death of console games is an exaggeration. Yet an uncertain future faces those console games companies that choose not to evolve rapidly.

The great games market split: the Big V revisited

In early 2010 there was strong reaction to our views that some console games publishers were "going down a very risky path… in the long term… they run the risk of becoming like traditional media companies. Cash generative, but declining and cost driven." So we were not surprised by the even stronger reaction last year when we said that "the games market had fundamentally split into Value and Volume markets, both by sector and geography. The two speed market this is creating may have more rapid and profound effects on the games market than it did on the media market, with meteoric rises for some and slow going for others."

In the last 12 months there has been significant growth in the Volume markets in terms of revenue, profit, investment and M&A, but we've also seen many Value market companies trying to pivot towards Volume through both acquisition (eg EA/Popcap) and organic growth. If the number of requests we're receiving from console games companies to conduct strategic reviews (usually as a precursor to investment or M&A) is an indication, then some of the best in the business are trying to evolve as quickly as possible.

So it seems like a good time to look at both the opportunities and challenges facing great console games companies in the brave new world.

New order, new opportunities

The balance of power in the games market today has fundamentally changed, with games companies nobody had heard of 5 years ago coming to dominate profits, investment, M&A and headlines. In our Global Games Investment Review 2012, online and mobile games are forecast to take 50 per cent games software revenue share at $41 billion by the 2015 financial year (14% CAGR 11F-15F).

Yet as discussed in our Console Games Review, console generated 48 per cent of global games industry software revenues and 62 per cent of total games industry revenues including hardware in 2011.

One hurdle is that where casual games were a significant driver for the 7th generation console market (>95 milion Wii, >10 million Kinect, >150 million DS sold), today many great online/mobile games are either free or cheap on increasingly capable mass-market platforms (iOS, Android, Facebook, QQ, GREE etc). This creates a potentially significant hurdle at the casual end of the market on the basis of price/convenience. Cloud gaming (OnLive, Gaikai) is still relatively early stage, but also holds promise as a platform in its own right. So while console games might remain a large long-term niche market, the next hardware cycle might not herald a return to mass market growth.

Despite these challenges, the best console games companies have great core strengths which could enable a successful pivot to online/mobile:

Strong brands

Large installed user bases

Strong cashflow

AAA games design quality

Genre dominance

But perhaps the greatest advantage they possess is players trained for decades to pay for fun. This is a specific advantage which many free-to-play games companies can only dream about.

Whales are not an endangered species

In free-to-play games (social, mobile, mobile-social, free-to-play MMO) a core part of game design is the focus on user acquisition, upsell and retention. While the numbers vary from game to game, it helps to think about ≥80% of revenue coming from ≤10% of users:

≤1% of users are "Whales" who will buy every virtual item no matter how expensive to show off to their in-game friends

5-9% of users are will buy one or more virtual items to speed up their achievement of specific game objectives

90-95% of users will never buy anything, but add value for other users and advertisers

In the revenue breakdown (below) from our Social Games Review - and again these figures vary from game to game - Whales are the most important player group commercially.

Paying players in social games.

Looking at the opportunity through this lens, console games companies swim in a sea of Whales, where players will pay $60 for a game they haven't even played yet. Epic Games is a great example of a console games company that took advantage of the opportunity with Infinity Blade for iOS (over $30 million revenue and which Mike Capps tells us is "still selling strongly and on top of the sales charts"). They also showed that there is still money on the table for high quality paid games despite the success of free-to-play.

So does how does Moby Dick catch Angry Birds?

The tools which great console games companies have for turning their businesses towards online/mobile games fall into three broad areas:

Cross-promotion: for user acquisition, upsell, retention and organic user growth. A strong core audience of organically acquired users might play longer, pay more and serve as evangelists to increase virality, lower user acquisition costs and become the bedrock of a strong online/mobile player community;

Game design: to cater to Whales and payers for whom game quality is a determining factor in their willingness to pay for their fun; and

Barriers to entry: strong brands and high quality are hard to replicate, enabling category dominance in ways which might not otherwise be possible.

Looking at console games companies this way, there is much that can be leveraged to pivot from Value to Volume markets.

A journey of a thousand miles begins with a single step (and a few questions)

While potentially attractive, the online/mobile pivot is not easy to plan or deliver. Before starting down that path, you might think about a few things:

Games: how could your games adapt to become great online/mobile core, mid-core or casual games?

Uniqueness: how might your games stand out in a market of hundreds of thousands of apps?

Accessibility: could your core games be made accessible enough for a mass market audience?

Genres: could you leverage your basic game mechanics to other game genres popular on online/mobile platforms?

Platforms: which online/mobile platforms could work for you, and does your team have successful experience on them?

Users: could your games attract millions or hundreds of millions of users?

Business model: could your games be adapted for virtual currency, virtual goods or advertising?

ARPU: could your business model work with ARPU in cents rather than dollars?

Costs: do you have the right cost/revenue model for online/mobile markets?

Development: could you reduce development cycles and costs by an order of magnitude?

Marketing integration: how could you integrate user acquisition, upsell and retention into game design and development?

Live team and community management: how might you manage a user community of millions of players in real time?

Geography: could your games operate across geographies and cultures?

Value to Volume transition: how do you bring your team with you? Who stays focused on console? How do you balance different internal cultures under the one roof?

Scalability: how do you become a business platform with scale advantages, rather than a string of hits?

Buy vs build vs partner: what do you need to succeed in online/mobile, and how do you get it (organic growth, investment, M&A, partnerships)?

Investment: how much financial runway do you have left, and how do you finance everything you need to do?

M&A: could you deliver your pivot by merging with a leading online/mobile games company?

We're having a lot of fun helping folks with these and other questions, and suggest that you don't let the grass grow under your feet before answering them. The clock is ticking…

Tim Merel is Managing Director of Digi-Capital, the digital investment bank focused on games across America, Europe and Asia (China, Japan, South Korea). As well as its fundraising, M&A and Strategic Review work, Digi-Capital publishes its Global Games Investment Review 2012.

Looking at the opportunity through this lens, console games companies swim in a sea of Whales, where players will pay $60 for a game they haven't even played yet.

I really like this observation.

Console gamers want to buy games. They're holding out their dollars and saying "Give us something good and we will pay for it." Publishers just need to find that magical way of convincing consumers that their game is good.

Currently Playing:

Looking at the opportunity through this lens, console games companies swim in a sea of Whales, where players will pay $60 for a game they haven't even played yet.

I really like this observation.

Console gamers want to buy games. They're holding out their dollars and saying "Give us something good and we will pay for it." Publishers just need to find that magical way of convincing consumers that their game is good.

I am willing to pay 40-60 dollars for a great game. But until I see that great game I am more than happy to buy used, or just download some game on my kindle. You have got to make me feel like I am getting some worth out of the game that I just bought.

I liken it to the movies. If I think I am only going to mildly enjoy a movie, I will just wait for it to hit the dollar cinema or even rent it on DVD. If they make me want to watch it with great trailers, reviews and even word of mouth then I will pay the 8 bucks to see it. Avatar had that, made me pay 13 dollars to see it in 3D. That is what the Developers need to get me to do to continue paying full price for admission.

If I were paid $60 for 1 hour of work and I could work the next 7 hours for similar pay rate. I would maybe work another hour to cover food/shelter and use the remaining 6 hours to play a game I bought for the first $60 :)

Currently Playing:

You dont have to buy a new game at release, sometimes some games go down in price within a year.

Hell look at FFXIII-2, it was 59.99 when it came out this year in Jan 31st and I found a new copy for 29.95 on Amazon.com.

@thread - Consoles are gonna last for another couple of years, at least another 2-3 generations unless everyone in the world can get their hands on broadband internet or a moderately good computer.

If I am not willing to buy a game at 60 dollars like I would with zelda, then I will wait it out until it is cheap. Gamespot ( !) usually will have a game go down between 9.99 and 29.99 during the holidays. I would rather buy it new if I can.

Currently Playing:

I think that by the next generation (not the up coming with WiiU, PS4 and nextBox - but the 9th gen) we'll see a more stabile gaming market: the freshness of mobile games will have worn off. The iPhone will be at least 10 years old when 9th gen comes, and the iPad will be at least 7, so by then I think we'll be able to see how the future for consoles will be like.

In 5 years we'll know how things will be the next 10-20 years of gaming. And if Nintendo manages to sell 50-75 million 3DS, they'll make more handhelds.

Currently Playing:

DanneSandin said:I think that by the next generation (not the up coming with WiiU, PS4 and nextBox - but the 9th gen) we'll see a more stabile gaming market: the freshness of mobile games will have worn off. The iPhone will be at least 10 years old when 9th gen comes, and the iPad will be at least 7, so by then I think we'll be able to see how the future for consoles will be like.

In 5 years we'll know how things will be the next 10-20 years of gaming. And if Nintendo manages to sell 50-75 million 3DS, they'll make more handhelds.

Or perhaps the future will be even harder to predict? Apple's market may keep getting greater for decades.

Currently Playing:

DanneSandin said:I think that by the next generation (not the up coming with WiiU, PS4 and nextBox - but the 9th gen) we'll see a more stabile gaming market: the freshness of mobile games will have worn off. The iPhone will be at least 10 years old when 9th gen comes, and the iPad will be at least 7, so by then I think we'll be able to see how the future for consoles will be like.

In 5 years we'll know how things will be the next 10-20 years of gaming. And if Nintendo manages to sell 50-75 million 3DS, they'll make more handhelds.

Or perhaps the future will be even harder to predict? Apple's market may keep getting greater for decades.

The only thing that would make it harder to tell the future is if iTV (or whatever it'll be called - they got that TV-box already, but I'm talking about an actual Apple TV) is released in 4-5 years time offering awesome game experince, OR PC's can over great virtual reality - you know, where you put on glasses and see everything in 3d... Something like that. Or maybe if we'll get small micro chips in out heads, streaming games directly to our brains rendering controls utterly obselete.